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Incorporating Equity Derivatives into the CreditGrades(tm) Model
Jan 1, 2010
Robert Stamicar and Christopher C. Finger present an extension of the CreditGrades model which allows for joint pricing of credit and equity derivatives. We had examined the use of implied volatility in the CreditGrades model in 2002, and presented some of these results in the CreditGrades Technical Document. The framework here is more robust, however, in that it makes the appropriate adjustments to the standard Black-Scholes volatilities; these adjustments are necessary since under the CreditGrades model, the firm's assets, but not its equity, evolve as a lognormal process. Robert and Christopher take advantage of this framework to investigate a variety of combinations of fundamental and market-based inputs to CreditGrades, and illustrate the approaches through examples on four individual firms.
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